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Thursday, December 1, 2011

The average number of days a borrower is delinquent before entering foreclose has now reached 631 days. We are closing in on the next major milestone; a full 2 years homeowners get to live for free in their homes after they stop making payments. What happens after these 2 years of prosperity? They pack their bags and move into a rental where they get to live maintenance free.

Remind me again why anyone would continue to make a payment once their home price fell below their mortgage amount and became under water? There are now 30% of homes underwater (and rising as home prices keep falling) with most of those home owners still paying and holding out hope. When these people make the logical decision to stop paying and live for free we will have the last leg down in the housing market.

At that point the losses will be socialized (seen in the rising price of gold and commodities) or prices will collapse and it will be buying time for the very patient investors that sit on the sideline.

I often explain my love for the markets to those that ask how I got so "into it" by comparing it to sports. Growing up you begin to play sports, you learn the rules of the game, watch the games on TV, and slowly you start to develop a relationship with the characters and daily events that compile a season.

It was the same way for me in the markets. I picked up a book one day, then read another, then made an investment, then began to track the daily movements, learn the characters, and it turned into a new type of "sports" that is constantly moving and changing globally 24 hours a day.

As with sports, there are certain characters within the arena that are more gifted than others. In sports athletes were born with god given ability that is usually combined with endless practice to achieve greatness (see Malcolm Gladwell's 10,000 hours chapter in his book "Outliers"). In the financial world participants may be born with a certain level of financial intelligence (see the Theory of Multiple Intelligences) which is then combined with endless work and study to achieve greatness.

It is these people that I try to read, study, and learn from through every article, book, or interview they provide. Just like when you hold your breath when a punt is kicked off to Devin Hester of the Bears, an interview or article with these market participants leave you in awe of their ability to take information and work it down to a logical outcome.

One of those names, who I apologize for gushing over continuously on this site, is Kyle Bass. We had the fortune of receiving his most recent letter to clients (free of charge) which I have posted below. It is an extremely simple conclusion of what is right ahead of us based on nothing more than logic, something most market participants have trouble putting together (due to psychological market factors that are beyond the scope of this discussion - see work of Daniel Kahneman or Dan Ariely).

Okay, enough about love for the markets for those that just want to know what is coming next. Here is the letter from the current take your breath away superstar of finance, Kyle Bass (Click "Full Screen").

An excellent presentation below from Chris Martensen discussing many of the topics in his now famous "Crash Course" and going into further detail on where we stand today in terms of energy needs.

The combination of exponential growth in population size and money supply combined with the exponential decline in cheap natural resources will be the dominant story of this decade and the most important concept for an investor to understand.

Chris does a great job of explaining these concepts in simple language and charts.

Yesterday the stock market soared 500 points higher after a coordinated global central bank easing move was announced. The plan reduced "swap line" borrowing costs for US dollars in exchange for foreign currencies. This opens a back door for the Fed to begin helping with the foreign sovereign debt bailouts as they face a liquidity crunch.

Bernanke has once again stepped in as the global printer of first and last resort. The only question is, does he have the power to hold up the world as the deflationary deleveraging continues to cascade down around him?

Wednesday, November 30, 2011

At the start of the last decade we entered a secular bear market for stocks and a secular bull market for commodities. These secular cycles last 15 - 20 years with the previous bull market for stocks and bear market for commodities running from 1980 - 2000. This cycle relationship ran all last century and continues today.

During a bull market you have steady growth over many years with sharp corrections along the way. This was seen in the last bull market for stocks in 1987 when the market crashed 22% in a single day. It was seen in silver in 2008 when prices plunged 60% in just a few months. Silver prices just recently corrected 48% from their May 2011 highs.

Understanding that you are in a secular bull market means you should look forward to these pull backs and use them as opportunities to add to your positions when prices go on sale. With major turmoil and liquidity constraints around the world, we may have another major buying opportunity ahead of us before we continue higher.

Before we get there it will be important to understand the fundamentals driving the bull market in silver. Silver, unlike gold, is both an industrial and monetary investment. An industrial investment means that it is used to produce goods such as electronics, solar panels, and biocide. The following chart shows the growth of silver demand in these three categories over the past decade:

Silver's industrial demand is combined with its monetary/investment demand to reach total demand. The following chart shows silver's total demand and the annual production (supply).

Silver's total demand has been greater than total supply for 11 years meaning that total global silver supply is shrinking. How much is left? Analysts now estimate that at the current pace we will run out of above ground available silver in 9 years.

Just like oil, there is plenty available silver in the earth's crust, but what is important is how much can come out of the ground under current production and at what cost. It takes years to bring a silver mine into production.

More than 80% of the silver mined comes as a byproduct of mining for other metals such as copper. This means if global growth slows (think China) and copper demand/pricing slows with it, silver supply will be cut tremendously even if the silver price is rising.

I will leave you with this simple thought experiment to help illustrate how much physical silver is available.

There is currently about 2 billion ounces of above ground gold available for investment. Historically the silver supply has been 15 times greater than the gold supply. There is about 15 times more silver in the earth's crust and the silver price historically has been 15 times less than gold due to this fundamental supply ratio.

So how much above ground silver is available today for investment?

Less than 1 billion ounces. There is currently less than half the amount of above ground silver available compared to gold. Silver is currently 55 times less expensive than gold, but based on the current supply ratio it should be at least twice gold's price.

To summarize: Global growth slowing means less silver produced due to its byproduct nature discussed above. Central banks will respond will an increase in the money supply to counter the slowdown. Global quantitative easing.

Investors will rush to silver to protect their purchasing power and when they do they will find out that there is no physical silver available. At that point a process called "price discovery" will take place when the paper price of silver will adjust to the correct supply and demand value.

Look forward to corrections as an opportunity to add to your positions. I am often asked the best way to begin to purchasing gold and silver. The company I recommend using is Goldmoney. I have purchased precious metals with Goldmoney for over 6 years, and members of my family use their services as well. Even if you do not plan on purchasing today it is a good idea to take a few moments of your time and open an account and have it ready so you have the ability to buy when the time is right. They are one of the most respected organizations in the industry, and I have provided a link here:

"Gold was the investment of the last decade. Silver will be the investment of this decade."

The top 4 lobbying organizations in America. 2011 is through the first 3 quarters. See if you can spot the trend....

1. American Bankers Association
•2010: $6,040,000
•2011: $6,690,000

2. Wells Fargo & Co.
•2010: $3,260,000
•2011: $5,890,000

3. JPMorgan Chase & Co.
•2010: $5,770,000
•2011: $5,800,000

4. Citigroup Inc.
•2010: $4,120,000
•2011: $3,800,000

America's favorite bank, closing in on their next bail out as the stock continues to plunge, came in at number 7:

7. Bank of America Corp.
•2010: $2,720,000
•2011: $2,210,000

Those frustrated with our current political/banking relationship need to understand that nothing will change under the current structure. Politicians are purchased by the banks. Things will only change when we reach the point of complete collapse in our debt markets. Those excited for this new America fortunately will not have to wait long.

Monday, November 28, 2011

Last week I was watching CNBC interview Richard LeFrak, one of the largest holders of apartment buildings in the United States. He shocked me when he casually mentioned that investors are now paying equal or greater prices for apartment buildings as they were during the peak of the bubble in 2007.

He then said it was an excellent time to invest due to strong fundamentals. In 2009 and 2010, when prices were significantly lower, he was on CNBC saying that he was on the sidelines. What could have changed?

They go on to say that investors are now paying 4% cap rates and lower for properties in major cities and there is a bidding war for these properties. From the article:

“There’s so much capital chasing too few deals—we call it “homeless capital,” said Bill Montgomery, President, Acquisitions & Investment, Sares-Regis. “REITs have been buying all the core properties and pension funds have had a hard time competing. We’re seeing money flowing into value add and development projects.”

To quickly review, a cap rate is the return on investment an investor pays for purchasing a property. If the property was purchased for $1 million and the annual income (after operating expenses are paid - not including financing costs such as the monthly mortgage) was $100,000, then the cap rate is 10%.

$100,000 / $1,000,000 = 10%

A investor's decision on the return he needs to purchase a property is weighed against the return he could receive by purchasing a competing asset (the opportunity cost). A 10 year government bond today pays only 1.97% pushing investors further out the risk curve in order to obtain yield just as they did in 2005 - 2008 leading into the financial crisis.

More from the article:

While development isn't coming back in a lot of real estate sectors, it is happening in multifamily, Montgomery contends. But that comes with increased costs. About 63% of respondents say construction costs increased by 5% over the last year.

However, that bet might be worth it, according to Tom Toomey, President and CEO of UDR, Inc. “We expect to see six million new renters over the next three or four year period," he said. "So why wouldn’t you want to invest more, build more, redevelop more—just seems like a great time and the numbers are stacked up in our favor.”

Let's look at a broad, easy, "answer" to this six million renter shortfall:

In the third quarter there were 6.1 million empty homes that were for sale or rent, according to the Census Bureau, or 4.6% of all U.S. homes.

If you were a renter, would you rather live in a small apartment with neighbors on every wall or would you rather live in a large home?

The reason this inventory is not being soaked up by new renters is because it is being held off the market by banks as shadow inventory. This is creating the mis-perception by developers that there is a shortage of inventory.

Let's look at a specific, real life example to illustrate this point. I live in downtown Charlotte, NC. The downtown area is small relative to the rest of Charlotte, and it is surrounded by a highway called 277.

Rents in this 277 ring have risen steadily over the last two years with high rental demand and low inventory available. The largest condo high rise in the city was completed in 2010 with luxurious new finishes and incredible amenities. Why does this matter if the units are currently for sale and not for rent?

The building now sits almost completely vacant.

The developer is in a battle with owners who signed contracts and refuse to close, and he refuses to drop prices. This is shadow inventory in downtown Charlotte. If the market continues to fall he may relent and give the property to the bank. The bank could then sell the property to an investor who could turn it into a rental property flooding the city with new apartments. (This has already happened in other buildings)

This covers the development portion of the apartment mania, but what about the cap rates? What about the prices investors are paying for existing buildings?

I have covered this topic more extensively in the past but I will review it again briefly.

An investor will have the ability to decide on a risk free government return at 8% (or higher) or a risky asset such as an apartment building at 4%. Cap rates on apartments will rise in tandem with government bonds creating a collapse in prices on these buildings.

In addition, the great majority of the apartments today are being financed through Fannie Mae and Freddie Mac; the American tax payer. This will end when Americans realize that they have all the real estate they need with the shadow inventory.

Investors purchasing today will face significant losses, unable to see the future atmosphere of interest rate pricing. This will provide an extremely attractive entry point for investors who have capital (and courage) to make purchases.

"We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and but she will never sit down on a cold one either."

- Mark Twain

"It's waiting that helps you as an investor, and a lot of people just can't stand to wait."

- Charlie Munger

"Live as if you were to die tomorrow. Learn as if you were to live forever."

- Gandhi

"One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do. I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I wait for a situation that is like the proverbial shooting fish in a barrel."

- Jim Rogers

"Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

- James Grant

"At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

- Ben Bernanke, March 2007

"Everything that needs to be said has already been said. But since no one was listening, everything must be said again."

- Andre Gide

"When people are getting richer and richer but they're not actually producing anything, it can't end well."

- Louis CK

"In economics things take longer to happen than you think they will, and then they happen faster than you thought they could."

- Rudiger Dornbusch

"I don't write about what I know. I write to find out what I know."

- Patricia Hampl

"Chains of habit are too light to be felt until they are too heavy to be broken."

- Warren Buffett

"Everyone has a plan until they get punched in the mouth."

- Mike Tyson

"Interest on the debt grows without rain."

- Yiddish Proverb

"You can have comfort, or you can have value. You cannot have both."

- Jim Grant

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

- Warren Buffett

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"Men who can both be right and sit tight are uncommon."

- Jesse Livermore

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

-Ludwig von Mises

"Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe. It's just a matter of the price paid for them."

- Howard Marks

"Whenever you find yourself on the side of the majority, it is time to pause and reflect."

-Mark Twain

"None are more hopelessly enslaved than those that falsely believe they are free."

-Goethe

"The longer the markets disobey basic rules of valuation, the bigger the opportunity for good investors to reap the benefits. Value investing works precisely because markets become dysfunctional at times."

-John Coumarianos

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

-Sir John Templeton

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"People only accept change in necessity and see necessity only in crisis."

-Jean Monnet

Requiring a central bank to print money to increase government's purchasing power invariably ignites a hyperinflationary firestorm. The result through history has been toppled governments and severe threats to societal stability.

- Alan Greenspan

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

- Henry Ford

"Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?"

-Steve Jobs

"I'd be a bum on the street with a tin cup if the markets were always efficient."

-Warren Buffett

"The market can stay irrational longer than the investor can stay solvent."

- Keynes

"While the government struggles to save one crumbling enterprise at the expense of the crumbling of another, it accelerates the process of juggling debts, switching losses, piling loans on loans, mortgaging the future and the future's future. As things grow worse, the government protects itself not by contracting this process, but by expanding it."

-Ayn Rand, 1974

"The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

- F. Scott Fitzgerald

"All our life, so far as it has definite form, is but a mass of habits - practical, emotional, and intellectual - systemically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be."

-William James

"Men it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

-Charles Mackay

The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.

- Stephen Hawkings

"Give me control of a nations money supply, and I care not who makes it's laws."

- Amschel Rothchild

Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.

- Sigmund Freud

Many of life's failures are people who did not realize how close they were to success when they gave up.